There is one single investing/trading strategy that has been proven to be the most successful strategy ever implemented in the financial markets.

1. The World’s Most Successful Trading Strategy.
In a recentarticle,we lookedatthe traditional approachtoa tradingstrategyknownas the Dogs of the
Dow.Several readershave questionedhow asimple strategylikethe Dogscanwork. Inthisarticle,we
will explainwhythe Dogsof the Dow can workand lookat a variationof the Stocktradingtips that can
be implementedatarelativelylow cost.
A commonquestionamonginvestorsishow astrategycan workwhena large numberof investors
alreadyknowaboutit.Researchershave shownthatif a strategyisbasedon soundinvestingprinciples,
it can workno matterhow well knownitis.Thisideaappliestothe Dogstheorywhichhas beenwell
knownformany years.Althoughmostinvestorsbelieve the theorydatesbacktothe 1991 book Beating
the Dow by Michael B. O’Higgins,we showedinourearlierarticle thatthe strategywasactuallyfirst
writtenaboutinthe June 1951 issue of the Journalof Finance.Althoughthe strategyhasbeenavailable
to investorsformore than65 years,it still worksbecause itisbasedonsoundinvestingprinciples.Those
principlesare diversification,timeandvalue.
First,the Dogs isa diversifiedstrategywithfive ortenholdings.Itisimportanttoholdseveral stocks
withinastrategybecause anyone stock can deliveraloss.Onthe otherhand,any stock can delivera
gain.By diversifying,investorsincrease the probabilityof owningastockthat deliversagain.
Second,thisstrategygivesstockstime togoup. Overthe past twentyyears,asthe internetallowed
investorstoobtainreal-timequotesandplace tradesquickly,expectationsforrapidreturnsseemto
have become common.Duringthe bubble of the late 1990s, some daytradersbelievedtheycould
consistentlyachieve triple-digitgainsandretire afterjustafew yearsof trading.Many of these traders
lostlarge portionsof theirportfolioswhenthe bubble endedandthe marketcrashed.Since thattime,
general expectationsof investorsseemtohave become more realisticbutthere are still manytraders
targetinglarge gainsinshort time frames.Thisispossiblewithsome strategiesbutformanyinvestors,it
couldbe bestto take a longertermperspectivelikethe one-yearperspective of the Dogsstrategy.
A longertermperspective,expectingtoholdpositionsformonthsorevenacouple of years,can provide
individualinvestorswithanedge overWall Streetfirms.Bigfirmsare oftenhighlyleveragedandto
manage risk,theyneedtotrade short-termstrategies.Theymightspendmillionsof dollarsanddevote
thousandsof hoursto develophighfrequency tradingstrategies.Then,theyspendevenmore moneyto
obtaindetailedmarketdatathatallowsthemtoexecute tradesinlessthanasecond.Asindividual
investors,we simplycannot compete withWall Streetfirmsinthistime frame.Byslowingdownand
lookingatlongertermopportunities,we cancompete andfindmarket-beatingreturnswithsound
strategies.
The rulesof the Dogs of the Dow holdspositionsforayear,providingenoughtimeforastock to deliver
a significantgain.And,perhapsmore importantly,the rulesof the strategyalsopreventthe mistakeof
takingprofitsearlyandmissingoutonbigmoves.Thisisa commonmistake of individual investorswho
take profitstoo quicklyonwinningtrades.
Third,the Dogs strategiesare all basedonvalue.AsWarrenBuffettnotes,“price iswhatyoupay, value
iswhat youget.” We needto focuson value asinvestorstoobtainmarket-beatingresults.

2. In the longrun, value strategiesappliedwithdiscipline andpatience have beenshowntooutperform
the market.Studieshave shownthisistrue nomatterwhichmeasure of value isused.Investorshave
foundsuccessbuyingstockswithhighdividendyields,low price-to-earnings(P/E) ratios,low price-to-
book(P/B) ratios,lowprice-to-sales(P/S)ratiosandothervaluationmetrics.
For the Dogs strategies,investorsoftenuse the dividendyieldtodefinevalue.Thishasthe added
benefitof providingincome while waitingforcapital gainstodevelopwhenthe stockprice rises.
Dividendsalsodecrease the downsideof lossessince the incomeoffsetsaportionof the loss.
But, the 1951 Journalof Financearticle usedP/Eratiosand demonstratedanyvaluationtool couldbe
used.Thisweek,we lookedatusingthe price-to-free cashflow (P/FCF) ratioanddevelopedalow-cost
Dogs strategy.
Free cash flowisthe amountof cash a companyhas leftoverafterpayingforthe cost of operationsand
makingrequiredreinvestmentsinthe business.It isnota widely-followedmeasurelikeearningsorthe
dividendyieldbutFCFmay be importantthanthose metrics.FCFmeasureshow muchmoneythe
companyhas leftovertopay for growthopportunitiesandtorewardinvestors.Potential acquisitionsor
constructionof newfactoriescanbe fundedbyFCF.Dividendsandshare repurchase programscanalso
be fundedwithFCF.Because FCFisusedto fundthe itemsthatincrease long-termshareholdervalue,it
may be amongthe mostimportantfundamental valueseven if itisn’twidelyfollowed.
In the opinionof some analysts,FCFisthe onlyforward-lookingmeasureof value since earnings,book
value andotheritemsinthe financial statementsare all determinedbywhathappenedinthe past.FCF
can be thoughtof as determiningthe future.Notsurprisingly,giventhisfact,P/FCFhasbeenshownin
academicstudiestobe a reliable predictorof future stockmarketperformance.
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